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Germany’s municipal utilities: will Covid, energy transition short-circuit profit, credit quality?

Germany’s municipal utilities face slimmer profit margins and growing pressure on credit quality as they contend with shifting patterns in energy consumption, tougher environmental regulations and fall-out from the pandemic.

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“The country’s 50 biggest municipal utilities face significant future capex as Germany has adopted stringent carbon-dioxide reduction targets just as competition intensifies from platform-based rivals,” says Karl Holger Möller, analyst at Scope Hamburg.

At the same time, municipal shareholders face spending pressures of their own, partly related to the economic shock of the pandemic on their budgets, which might encourage them to reduce financial backing for the utilities and demand heftier dividends.

“All these factors risk short-circuiting the profitability and credit quality in the sector,” says Möller. “Credit metrics have deteriorated further in 2021 and will continue to do in the medium-term,” he says.

“This puts extra pressure on the utilities to find timely and adequate funding and might drive further consolidation in the sector, not least because of the potential inability or political reluctance of municipal shareholders to provide the necessary funding,” he says. The utilities are likely to widen their sources of funding partly by tapping the growing market for green bonds.

Scope Hamburg has assessed the principal credit metrics of the 50 major German municipal utilities with a turnover of at least EUR 300m (median 2019 EUR 643m) for the period 2017-2020 to establish the most important trends. Three quarters of the utilities benefit from high cross-municipal and horizontal synergies, while 65% do so in local public transport. Operating cashflow generation from recurring regulated downstream activities and long-term purchase power agreements (PPA) is mainly predictable.

The municipal utilities face high capex amounting to EUR 7-8bn per year. Major capex will be allocated to the energy and mobility transition, synthetic material quota recycling and the fibre-to-the-building expansion in telecommunication. Important drivers for capex spending are diversified CO2-free gas/hydrogen, wind and solar power generation, battery, hydrogen and bio-methane storage, waste treatment facilities and the development of smart cities.
“Current profitability in the sub-sector will deteriorate further as a result of competition, challenges in flexible energy production, procurement and trading, commodity price swings and customized service and portfolio management solutions, and curtailed earnings from regulated business,” says Möller.
Among the adverse factors the utilities face are losses of grid licenses and disadvantages in offering value-added, digital services, such as those associated with smart cities. High structural deficits and reduced base demand in public transport will leave their mark, squeezing utilities’ profitability through 2025 despite the availability of government financial support linked to the pandemic.

The most important credit metrics of German municipal utilities generally deteriorated between 2017-2020. The utilities’ median EBITDAR-margin fell to 9.3% in 2020 from 10.6% in 2017. Leverage rose to 4.5x from 3.1x in the same period. The municipal utilities were highly dependent on external funding. The capex cover ratio deteriorated to 0.8x in 2020 from 2.1x in 2017, indicating that high capex needs were met only through additional external funding.